Commercial Loans Blog

Seventy-five percent of the time when a developer calls a commercial mortgage broker to help him place a commercial construction loan - that deal is NOT do-able. Why? Because the developer doesn't have enough equity in the deal. He doesn't have enough skin in the game.

"Gee, George, how can you make such a blanket statement like this? How could you possibly know that the developer doesn't have enough equity? Are you the Great Oracle of the Indiana Cornfields?"

Answer: Banks love-love-love to make commercial construction loans, assuming the world needs what the developer is trying to build - like more office space in San Francisco. Banks love to make construction loans because they are short term loans and because they very profitable. Why are construction loans so profitable? Because the bank immediately earns one to two points up-front on the entire loan amount, even though the developer's first draw might only be for a few thousand dollars.

Therefore any developer with half a brain calls a local bank long before he calls a mortgage broker. And if the banks wants to make construction loans, yet it turns the deal down anyway, there has to be a reason. Ninety percent of the time that reason will be because the developer doesn't have enough of his own - or his partners' - money in the deal. Rather than try to raise more equity, he tries a mortgage broker.

Therefore, if you are a mortgage broker, the first thing you have to do, before you waste a lot of time, is to determine if the developer has enough equity in the deal. But what counts towards the developer's equity? It is the sum of the following:

The developer's cash down payment on the purchase of the land.

It does NOT include the principal and interest payments on the land loan used to buy the land. Payments on a land loan don't add value to the project. In theory, a developer is supposed to pay cash for the land.

But definitely include any appreciation in the value of the land since the buyer purchased it, either because of time (maybe the developer wisely bought the property in 2009 at the bottom of the market) or because of the happening of some external event, such as the completion of a freeway off-ramp on the subject strip or the opening of a nearby Wal-Mart.

Any increase in land value due to a zoning change or use change.

Any increase in value of the land due to assemblage. Sometimes an assembled parcel is worth far more than the sum of the purchase prices of the various parcels. Imagine a developer who is able to buy six ugly, old rental houses along a busy strip and combine them into a site large enough for a modern new strip center (called a mini-mall in Southern California).

Any monies already expended for architect's fees.

Any monies already expended for engineering fees.

Any monies already expended for legal fees, especially when used to get the zoning or use changed.

So how much equity is enough? Generally a developer has to cover 20% of the total cost of a project.

Don't forget, when you are computing the Total Project Cost, to include such Soft Costs as the Interest Reserve, any loan points, appraisal fees, toxic report fees. structural engineering reports, plan check fees, and utility hook-up fees. Any of these fees that are prepaid count towards the developer's equity in the project.

Remember, the developer, or his equity partners, must contribute at least 20% of the Total Project Cost. If the property is a business property, such as a hotel, restaurant, or marina, the developer may have to contribute 30% to 40% of the Total Project Cost.

If you learned something today, would you kindly give me a social media doggie treat, like a Facebook Share, a Linked-In Share, a Twitter Re-Tweet, or a Google-Plus atta-boy? It's how I can judge whether or not our readers are digging these articles. Thanks so much!

Got some loan agents working for you or some buddies who are also in commercial brokerage or commercial mortgage brokerage? It would be terrific if you would please forward this training article to them. And if someone was indeed kind enough to forward this article to you, you can sign up to receive these free training articles in commercial real estate finance by going to our blog and typing in your email address below my rump-ugly picture. :-)

When I teach commercial real estate finance, I try hard to use simple terms (baby language), lots of repetition, and tons of examples. Although I ended up graduating from law school with honors and passing the California Bar on my first attempt. I also remember driving my law school instructors absolutely crazy with questions. "I'm sorry, Judge, but I don't get it." So my training courses are intentionally aimed at folks of average intelligence (like me). I truly believe the best thing you can do for yourself in this business is to take my classic 9-hour training course. Countless successful brokers have sought me out at trade shows to shake my hand and thank me for this course. Heck, I expected to be dead by now (heart problems), so I created this program with great care to train my two wonderful Eagle Scout sons after my death. God bless modern medicine! Ha-ha!

If you put two plastic bottles into a recycling container you get to take the lovely Jennifer Aniston out to dinner. (If you haven't seen the Jennifer Aniston movie, We're the Millers, you are missing a true treat.) The recycling bottles deal is the only deal on Earth better than the following.

C-Loans is now placing business loans, rather than simply commercial real estate loans.

How would you like to be able to turn on a flow of commercial loan applications like turning on a faucet? Hey guys, do you think that I really get to live near my daughter's $45,000 per year high school because I am so handsome and charming? Helloooo? Look at the picture. It's because I am a master marketer, and everything I do is repeatable. My son, George IV, has taken my marketing course, and he is emerging as even more effective marketer than me.

Do you sometimes look at my marketing courses and say, "Gee, George, I don't doubt that you can teach, but I don't have any dough." I'll give you the training course of your choice if you convince a bank to join C-Loans. This is no big deal, guys. Just send them the link to this sales page. Duh. Bankers are getting pressure today from their bosses to make commercial loans and SBA loans.

I don't get you guys. You are so focussed on saving the borrower 1/2% on the interest rate that you forget that the borrower's business actually needs money. If they had money right now, they could triple it in 18 months. And you're risking everything to try to save them 0.50%? Really? Are you retarded? Blackburne & Sons will issue your client a Loan Approval Letter for free! We're thrilled to do this because we know that 60% of the time your best bank will leave your borrower standing at the altar looking stupid. Your borrower needs money!

Lenders Use Release Clauses So Developers Can Sell Off Lots, Homes or Condo's

Let's suppose a commercial lender - a bank - makes a $2 million commercial loan to a developer on a residential subdivision. The developer uses the proceeds of this commercial loan to obtain an approved subdivision map, to install the horizontal improvements (streets, curbs, gutters, water, sewer, power, etc.) and to market the 100 residential home sites. Now the developer is done, and he is ready to sell off his first residential lot for $40,000.

But wait. The lot buyer isn't going to fork over his $40,000 unless the developer is prepared to hand over the lot free and clear of any mortgages. The bank has a $2 million loan against the lot (and admittedly the other 99 lots). How do we get rid of the $2 million bank loan with the proceeds of just a $40,000 lot sale?

The sale will be accomplished using a partial release clause in the loan documents. A partial release clause is an agreement between the commercial lender and the borrower whereby a mortgage that blankets two or more parcels will be released from a particular parcel upon the payment to the commercial lender of a previously-agreed amount of money. For example, "The commercial lender agrees to release its mortgage against residential lot number 17 upon the payment $20,000." The bank gets $20,000 from the sales proceeds of lot number 17 (a nice culs-de-sac lot), and the developer gets to pocket the remaining $20,000 as his profit.

But be careful here. What if this new residential subdivision has just 15 culs-de-sac lots and 10 nice lots with views? What if the rest of the lots are stinky? Suppose the developer is able to sell all 25 premium lots for $40,000 each and gives the bank half the proceeds. That's $500,000 for the bank and $500,000 for the developer. Now the bank is owed $1.5 million, and its loan is secured by the 75 remaining lots.

What happens if the non-premium lots cannot be sold for any more than $18,000 each? If the initial release price per lot was set at $20,000 the problem soon becomes apparent. The developer cannot sell any of the remaining lots. Even if the bank cooperated and let him sell the lots for $18,000 each, this would only bring in another $1,125,000. The developer would still end up owing the bank $375,000, and all of the collateral would be gone!

Okay, obviously the bank needs to do something in order to protect itself. One way the bank will protect itself is that it will ask the appraiser to assign an anticipated sales price per lot. The release price per lot will no longer be a uniform $20,000 per lot. Instead, the premium lots might have a release price of $30,000 each and the non-premium lots might have a release price of $17,000 per lot.

But what if some of the lots cannot be sold for any reasonable price? What if consumers pick over the subdivision and leave 35 non-premium lots unsold? The developer would still owe the bank almost $600,000 and the bank would only have as collateral a bunch of undesirable lots.

To make sure that the bank does not end up with a bunch of unsalable lots (or condo's), the typical partial release clause will have a provision whereby the developer must pay down the construction loan or land development loan by 115% to 125% of the release price before the bank will release a unit. Therefore, in our example, the developer will have to pay down the land development loan by 120% of $30,000 ($36,000) in order to get a premium lot (culs-de-sac or view lot) released. This way a developer does not get to keep a lot of the profit and leave the construction lender with a bunch of crumby, unsellable lots or units.

As a result of current banking crisis, very few commercial construction loans are getting funded. I have warned commercial mortgage brokers extensively, in this blog and on the main C-Loans website, not to waste precious time trying to place commercial construction loans or residential subdivision construction loans. There is one exception to this rule.

If a commercial property will be 51% owner-used, it is still very possible today to obtain an SBA 504 construction loan. More precisely these loans are known as CDC/504 loans.

Despite the name, these loans are not made by the Small Business Administration. Instead, SBA 504 (CDC/504) loans are made as a conventional first mortgage loans with a piggy-back second mortgage that is recorded concurrently.

The first mortgage is actually made by a conventional lender, typically a bank. The piggy-back second mortgage is also typically the bank or 504 lender for about 45 days, but then the second mortgage is assigned to a Certified Development Corporation and guaranteed by the Small Business Administration.

After the construction period, the underlying conventional construction loan converts to a long term conventional permanent loan. This loan is often fixed for five to ten years and is typically amortized over 25 years. The conventional loan will typically have a term of 10 to 25 years.

The piggy-back second mortgage is always fully-amortized over 20 years and is written at a government-subsidized interest rate about 1.5% lower than the typical conventional commercial first mortgage.

The big advantage of an SBA 504 loan is that the owner only has to contribute 10% of the total cost of the project, including loan fees and other soft costs. The owner can often include some heavy equipment costs in his total project cost, meaning that he gets to buy some heavy equipment at low commercial real estate loan interest rates. In contrast, on a conventional commercial construction loan, the owner usually has to contribute 20% to 35% of the total project cost.